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14th Consultative Group Meeting on Indonesia: Statement by Andrew Steer, World Bank Country Director


by
Andrew Steer
Country Director, World Bank Group
January 20, 2005

Mr. Chairman,

Ministers,

Governor,

Excellencies,

Friends

 

The past year has been one of remarkable progress and transition in Indonesia. The fact that the Government is chairing this CGI meeting for the first time is indicative of the new spirit in the country – which we very warmly welcome.

 

The political significance of the past year is obvious. No human being in any country in history has ever won as many direct votes in a fair and free election as did Dr Susilo Bambang Yudhoyono.  This is a huge accomplishment for this nation, and an extraordinary mandate for this new Government.  It is not surprising that this has boosted pride and confidence, which in turn benefits the economy.

 

The past year has witnessed the substantive and symbolic end to the economic crisis.

 

The exit from the IMF program was extremely well managed by the Government (and by the IMF)..

 

Public debt fell rapidly below its legal limit of 60 percent under the Finance Law, and now stands at around 50 percent. (In the Philippines it is 90 percent).

 

Most important, the rate of income poverty fell to below its pre-crisis level for the first time.

 

When we sat here a year ago the weak investment climate was the highest item on the agenda. Investment had risen by less than 2% in 2003, of which 80% was in the property investment – not a healthy story.

 

Today investment is growing at well over 10 % per year. Capital goods production is up by around 15% over the past 12 months, and capital goods imports by over 30%.

 

Last year we agreed that investors needed two things – first, a stable, predictable economy. Second, a confidence that the Government was moving in a clear direction to improve predictability of the policy regime and help reduce the cost of doing business. At that time investors did not yet believe that they were getting both of these. Now it seems that they are beginning to believe that they are.

 

This was the message from last week’s CGI Investment Climate Working Group (which brings together the Chambers of Commerce with the Government). And it was also the clear message from the highly successful Infrastructure Summit this week.  Nobody left the Summit believing that this was business as usual. Not all investors are yet converts – but almost all are willing to give the benefit of the doubt.

 

Positive investor perceptions are indicated by the regular improvements in Indonesia’s bond ratings over past months, and in the historic high reached this month on the Jakarta Stock Exchange.

 

There is now a good platform on which to build growth in the years ahead. 

 

A budget deficit of 1 percent is manageable.

 

Inflation is down to 6%

 

Interest rates are down . Working capital rates are the lowest in 10 years.

 

Government bond rates are down substantially, and the yield curve has flattened, implying a growing confidence about the future.

 

The Government’s 100 Day program is coming to an end, and while not everything will have been achieved, few will doubt that the new Government’s commitment to change.

 

So does this all mean plain sailing from now on?  No it doesn’t. There remain risks and potential pitfalls that the Government recognizes well. 

 

What then are the potential clouds on the horizon?

 

Macroeconomic Risks. Here care must still be taken. Its important to remember that even although Indonesia’s public debt stock is declining rapidly into safe territory, the profile of debt service payments is still a big burden. As a result, the Government needs to borrow $10-11 billion each year for the coming 4-5 years. (Around $7-8 billion of this is to effectively pay back existing debt).  This will be quite manageable, but only if the macroeconomic stays strong. Any instability will make such borrowing much more expensive.

 

Financial Sector Risks.  Obviously the banking system is much stronger than it was.  Capital Adequacy ratios are broadly adequate and the scale of non-performing has continued to fall.  While the financial system is certainly much stronger than in earlier years, it is not yet strong. State-owned banks  - which make up more than a third of the banking system – are the Achilles’ heel of the system. It is difficult to gauge the true state of these banks given the role of Government bonds on their balance sheets, and weak governance structures.  Improving the management of these banks is an urgent priority.  It will be tempting to pressure these banks to make loans for projects that are high priorities of the Government. But such pressure would undermine the reforms in governance that are so urgently needed.

 

Of course there are huge opportunities to deepen the non-bank financial institutions – pension funds, insurance, capital markets. As the Government noted in the Infrastructure Summit these institutions can play a much bigger role than they currently do in helping longer term growth. There are many good ideas here – and we look forward to significant reform in the coming year.

 

The Risk of Unmet Expectations:    Given such a well-articulated Government strategy, everybody now knows what to expect, and the clearly  Government needs to act quickly. 

·         It needs to deliver new laws in Mining, Electricity, Investment, and regulations in numerous areas in just a few weeks.

·         It needs to begin to tender the 91 infrastructure projects beginning on March 1. 

·         And people will be watching closely as to whether delays in investment licensing, customs procedures etc are reduced, as promised.

 

Pace is essential. But there is danger in too much speed also. If the Government is seen to cut corners in a desire to get projects moving, its strong reputation for governance and transparency could be quickly undermined.

 

A fast pace is thus necessary, but one in which professional input and transparency characterize the process.  This requires a civil service at Echelons 2 and 3, as well as Echelon 1 to perform aggressively and in harmony as part of the team.

 

This raises a major challenge that the Government must deal with. The ambitious agenda of the new Government can only be delivered if the civil service is more responsive than it has been in the past. Businessmen are not yet seeing the very good decisions of the top leadership translated into behavior at the middle level bureaucrats with whom they deal day by day. Civil service reform – including greater clarity of accountabilities – is an urgent complement to the excellent policy decisions being made by the Government.

 

We are confident that the Government is aware of and plans to handle these challenges and risks

 

How then do we see things going forward? We share the Government’s projections for 2005. We are confident that investment, already rising from its low levels, will continue to rise. This is a reflection of renewed confidence, and is driven by the fact that capacity utilization is higher than at any time in the past two decades.

 

For subsequent years we see prospects of 6 percent growth, or even higher, if (and only if) policy and governance reforms are seen through forcefully and if the international climate remains relatively benign.

 

We hope and expect to see the nature of the development question for Indonesia changing.

·         For 1998-2002 the question was: how to restore macroeconomic stability?

·         For 2003-2004 the question was: how to restore investment?

·         For 2005 and onwards (as growth is achieved) the question should shift from quantity to quality. How to ensure that growth is  high quality? 

 

Embedded in this transition will be questions such as:

·         How to make investment more pro-poor?

·         How to ensure appropriate geographical balance, and how to support rural growth?

·         How to ensure environmental sustainability?

·         How to invest in a way that promotes a rapid movement up the “value-added’ chain?

·         How to invest in human development in a way that  enables the nation to compete in the tough East Asian environment?

 

If at next year’s CGI we are discussing these new questions it will be a remarkable sign of success. The new Government has made exactly the right decision to focus in its early days on creating a momentum in the economy. In this it seems to have been spectacularly successful. Such success now breeds the need for more hard work. How to ensure high quality?

 

Thus perhaps the next Summit should be on “Pro-poor Growth” or on “Education for a Competitive Indonesia”.

 

Mr. Chairman, we commend the Government of Indonesia for your wonderful start.  We admire the path you have embarked upon. The path ahead towards high quality growth is not an easy one, and we feel privileged to support you as partners as you travel it.

 

Thank you.

 


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